As a small business owner, you may have come across the term ‘due diligence’ when it comes to investments. It may be that your business has been targeted as a potential investment opportunity by external parties such as angel investors or venture capitalists. It may be that property belonging to your business forms an essential feature for the incoming investment.
Alternatively, you may be looking at investment opportunities as part of your wider business portfolio planning and are keen to understand how it all works.
In this article, we’ll discuss investment due diligence in general terms, how it works in practice, and why it forms such an important stage of making any investment.
What’s meant by the term ‘due diligence’?
The term ‘due diligence’ is a legal expression referring to the process by which a party investing in a business, property, or other asset types will undertake certain checks on the asset to ensure that it represents a sound investment and is worth the value that’s being attached to it.
Due diligence can take many forms, from physical inspections to desktop enquiries and is likely to involve professional expertise depending on the circumstances.
Why is it important?
The reason why it’s so critical is that a key feature of English law is the principle of ‘caveat emptor’, meaning ‘buyer beware’. This means that the buyer (or investor in this case) must satisfy themselves as to an asset's strength, condition and value.
Unless agreed to the contrary, there will be no claim against the other party for failure on the part of the investor to carry out appropriate due diligence on the asset if it fails to represent a good investment.
What does investment due diligence involve?
The due diligence checks will vary greatly depending on the investment in question.
For example, if we’re referring to investment in a company, the due diligence will likely focus on the following areas (amongst others):
- Financial accounts (profit and loss and balance sheet)
- Management accounts
- Budget plans and cash flow forecasts
- Business taxation aspects
- Litigation (current / historical / pending)
- Shareholding structure
- Intellectual property rights
- Business contracts
- Suppliers and customers
The aim is to get a complete and detailed picture of the business concerning its strengths and weaknesses. This helps gain a more accurate view of the actual underlying value of the company and the likely risks and upsides associated with investing in it.
In regards to investing in property, either as part of a company investment or as a stand-alone investment opportunity, the focus will be on the following:
- Legal title ownership checks at HM Land Registry
- Tenure (i.e. freehold / leasehold / length of lease etc.)
- Rights and encumbrances checks
- Services (electric, gas, water and internet connectivity, etc.)
- Structural survey
- Mortgageability status
- Local authority searches
- Any environmental issues regarding the property
Property due diligence is carried out to ensure that it represents a sound investment without any significant issues that may affect its structural integrity, value, future saleability, or ability to provide reasonable security for lending purposes.
When should due diligence be carried out?
Investment due diligence should always be carried out before the investor becomes contractually committed.
Which advisers are typically involved in the due diligence process?
Lawyers will usually be involved in all the legal elements. Chartered Accounts will also generally be involved in advising on the accounting and taxation aspects and running the rule over the financial disclosures.
When investing in property, it’s commonplace for them to appoint a Chartered Surveyor to undertake a complete structural survey, mainly if the property is old or high value, has listed building status, is of non-standard construction or has any other peculiar aspects related to it.
Investment due diligence is crucial to make informed and sound investment decisions. Seeking professional advice and support from lawyers with appropriate expertise is highly recommended to ensure that all legal aspects of the due diligence process are thoroughly assessed and addressed.
LawBite’s team of experienced lawyers can provide comprehensive legal assistance for all your commercial, corporate, and employment matters. Don't hesitate to contact us today to learn how we can help you with your due diligence needs.
About the author
Ashley Gurr is a commercial and contract lawyer at LawBite. Ashley has over 15 years of experience in private practice helping SMEs and in-house for an international consultancy group advising on commercial agreements and a multi-national utility giant in a contract strategy role.